A bounce in oil prices and rising confidence in forecasts that the industry's supply glut will end heading into 2017 are luring speculative dollars back into U.S. exploration and field services stocks.
Analysts project a broad recovery among domestic energy producers in 2017. The companies anticipated to rise first and show the biggest earnings gains next year are companies that have squeezed operating costs and work in high-production plays, led by names including Diamondback Energy (FANG) and Parsley Energy (PE). Field services providers Halliburton (HAL) and Schlumberger (SLB) are also forecast to benefit from early price strength, as demand recovers for services related to hydraulic fracturing and other well-completion operations.
"As oil prices rise, which we think they will, the best section to be in is exploration and production, since they are the most impacted by commodity prices," said Brian Youngberg, a senior energy analyst at Edward Jones. "We've seen good performance from them since oil bottomed in February."
The price of West Texas Intermediate oil futures rebounded over the past three weeks following a 24% pullback from June to early August. The pullback found support near $40 a barrel, an important psychological level and well above lows near $26 experienced in February — the bottom of the industry's deep, two-year trough.
That support, and bullish projections from the International Energy Agency, were reinforced in the past week by suggestions that Saudi Arabia may support a production cap among Organization of the Petroleum Exporting Countries members. The combination helped overturn concerns that the price rebound may be simply a replay of last fall, when oil rebounded 35% from August to October but then collapsed to record lows.
The IEA's August report noted that demand finally began to outpace supply in July, suggesting that oil might find an equilibrium price sooner than expected. Some analysts put that equilibrium at between $45 and $50 a barrel. On Friday, U.S. crude rose 0.6% to $48.52 a barrel, capping a 9.1% jump for the week.
The combined factors dropped a starting flag for investors anxious to be early into an upturn in the energy cycle. Stocks in IBD's U.S. oil and gas exploration and production group collectively climbed 12% in the four weeks to Friday. The group now ranks 10th among 197 industries tracked by IBD. Oil and gas field services, which ranks No. 82, slipped 1% over the past four weeks.
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With shale oil having turned the U.S. into the leading global swing producer, analysts expect U.S. production and services plays to be among the earliest cyclical stocks to react.
Which should you consider? Here are several early options.
The Best In West Texas Shale Oil
The Permian Basin in West Texas is the epicenter of low-cost production of U.S. shale oil. Diamondback and Parsley focus on the Permian. Parsley announced on Aug. 15 it would pay $400 million to expand its drilling rights by nearly 12,000 acres in the Permian. At the same time, Concho Resources (CXO) expanded its Permian footprint by 40,000 acres in a $1.6 billion cash-and-stock deal.
Diamondback has large holdings in the Permian's Clearfork, Spraberry, Wolfcamp, Cline, Strawn and Atoka formations. This month, the company raised its full-year production guidance to 38,000-40,000 barrels per day from an earlier outlook of 34,000-38,000 barrels on increased activity in the second quarter.
Companies with positions in the Permian in Texas and the STACK — the Sooner Trend Anadarko Basin Canadian and Kingfisher Counties play — in Oklahoma are also poised for growth over the next few years, according to Youngberg.
Unlike North Dakota's Bakken shale oil play, the Permian holds multiple horizontal layers of deposits, particularly in the Wolfcamp and Spraberry formations. From a single production pad, producers can drill down layer by layer and run radial wells out into each stratum of deposits. In other shale regions, producers typically get one layer of deposit per well.
Youngberg says the infrastructure in the Permian is also better, thanks to the play's age. Companies have been drilling vertical wells in the Texas play for nearly a century. A complex network of pipelines already provides the basin with what analysts call "takeaway capacity." The Bakken continues to be constrained by a lack of such capacity and must depend on more expensive railroad transport to supplement its limited pipeline network.
In its Aug. 15 update, the Energy Information Agency said that production from the Permian will rise by 3,000 barrels per day in September to 1.977 million bpd. Bakken production, meanwhile, is seen falling by 26,000 barrels per day to 942,000 bpd.
In a note released Aug. 10, Deutsche Bank analysts wrote that "Permian Basin producers (are) likely to offer the best opportunities for production beats by year-end 2016, particularly at Diamondback."
Deutsche Bank raised its price target on Diamondback stock to 112 from 104. But the analysts warned that poor execution in developing its Spraberry sites and a relatively high exposure to a decline in oil prices are downside risks.
Diamondback earnings fell 37% in Q2, and the company is expected to post declines in the third and fourth quarters, before rebounding 126% to $2.37 per share in 2017.
The stock broke out above a 96.11 buy point Thursday from a classic flat base, a price pattern on a stock chart that can indicate the company is poised for an upward move. It remained in buy zone Friday, adding a few cents to close at 98.59.
Possible Permian-Based E&P Targets
Callon Petroleum (CPE), which has assets in the Midland basin region of the Permian, reported Q2 earnings Aug. 8 that were above Wall Street estimates. The company's production rose 8% in Q2 vs. Q1.
Unlike most other U.S. E&P companies, which continue to post losses or earnings declines, Callon's EPS climbed 25% in Q2 after two quarters of flat results. Analysts predict earnings growth at 47% this year, with a 95% surge in 2017. Revenue growth is forecast at 48% this year and 47% in 2017.
The company's shares ended Friday 11.5% extended above a 12.66 buy point from a cup base, one of the most common chart patterns seen in top growth stocks before their big moves.
RSP Permian (RSPP) also announced earnings on Aug. 8, with a greater-than-expected loss — its ninth decline in the past 10 quarters. Revenue eked up 4% to top analysts' targets. Production, meanwhile, surged 33% year-over-year, prompting management to raise its full-year production outlook to between 26,500 and 28,500 bpd, up from a prior guidance of 23,000 to 27,000 barrels. The company's holdings are primarily in the Permian's Spraberry and Wolfcamp areas.
Analysts expect a loss of 17 cents per share this year, rebounding sharply to a 61 cent gain in 2017. Estimates for a 9% slip in revenue this year improve to a 52% gain in 2017.
Deutsche Bank raised RSP's stock price target to 48 from 39, but it warned that infrastructure delays could constrain growth.
Oklahoma's Piece Of The Shale Oil Game
Another older area revived by new production techniques, Oklahoma's STACK, has "superior geology" vs. other plays, Youngberg says, and it has turned out to be more oil-weighted than initially thought. He said the play's full potential is just now being explored.
Newfield Exploration (NFX) is a key STACK player, expanding its holdings in the play by 40,000 acres through a $470 million deal with Chesapeake Energy (CHK) in May. Newfield now owns rights to 265,000 acres in the area.
Continental Resources (CLR) — led by Donald Trump's possible choice for energy secretary, Harold Hamm — is a bellwether for the industry. While the company has a large chunk of its assets concentrated in the more expensive-to-produce Bakken play, it is working on increasing production out of the STACK. The company reported it held leases to 183,000 acres in the play at the end of Q2.
Deutsche Bank raised its price target on Continental to 56 from 54 over "higher confidence surrounding Continental's STACK play."
Continental reported an 18 cents-per-share loss in Q2. It is projected to post a second straight annual loss this year, before rebounding to a 25 cent gain in 2017.
U.S. Oilfield Services Outlook
E&P companies aren't the only group that can take advantage of a new oil upturn. James Williams, an economist at energy consultant WTRG, said oil field services providers led by Schlumberger and Halliburton are likely to be early beneficiaries from any oil price gains.
"If oil prices go up, they will benefit first of all from increased activity, as unit sales will go up, and secondly they will benefit from higher prices to restore some of the price cuts they've made," Williams said.
Schlumberger CEO Paal Kibsgaard said in July that the company is renegotiating contracts after offering deep discounts during the oil price slump.
Global markets are headed for a significant supply deficit, Kibsgaard said, assuming steady growth in energy demand. He also said that the level of oil and gas exploration activity is at unprecedented lows, so there are "huge growth runways" for oil field service providers.
Halliburton has also said it sees signs the worst of the oil crash is over, commenting in July that "the North American market has turned."
Shares of both Halliburton and Schlumberger are climbing out of long-term consolidations. Schlumberger is technically in a buy range above an 82.06 flat base buy point. Halliburton is finishing up the fifth week of a flat consolidation. (Learn how to read stock charts to reduce investing risks and increase gains in our How To Invest section.)
But E&Ps and oil field service providers will tread carefully to avoid mistakes made last year when oil prices rose, only to come crashing down again in October after sanctions on Iran were lifted and the Chinese stock market crashed.
Global Economy Poses Risk; OPEC, India Possible Upsides
Williams said the oil market doesn't have "steady optimism" as Brexit hangs over Europe, growth in China's economy stalls, and U.S. growth remains sluggish.
"The standard places you look for increased demand aren't there," he said. "If there is one bright spot on the demand side, it is India. Its growth in consumption is pretty steady — it's the new China in oil consumption.''
The IEA's August report forecast weaker demand on a "dimmer macroeconomic outlook" in 2017. Messages from the supply side appear equally bearish: Saudi Arabia boosted production to a record 10.67 million bpd in July, as the country's June shipments rose to a three-month high.
But the news had little effect on prices, and Saudi Energy Minister Khalid al-Falih boosted prices this month by hinting that the kingdom would support a production cap. Analysts suspect a possible deal on the sidelines of the International Energy Forum, set for Sept. 26 to 28 in Algeria, despite comments from Russia's Energy Minister Alexander Novak that he didn't see a reason to renew freeze talks that failed earlier this year.
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